Investments

1. Joe's Clambake Company is considering the purchase of a C130 airplane to help spot monster clams on the bottom of Chesapeake Bay. In estimating the worth of adding the plane to the company the following cash flow analysis has been developed:

Cash inflow at the end of year 1: $12,000
Cash inflow at the end of year 1: $12,000
Cash inflow at the end of year 1: $12,000
Cash inflow at the end of year 1: $12,000
Cash inflow at the end of year 1: $12,000
Cash inflow at the end of year 1: $30,000

If Joe's required rate of return is 10%, how much is the plane worth to him today?

b. You have decided to sell Creative Crafts for 4,000 and to use the proceeds to buy $4,000 of International Steel stock with a beta of 2.0. After the transaction is complete, what will be the new beta of the portfolio? (Disregard any commissions on the buy and sell transactions)

3. You have been scouring The Wall Street Journal looking for stocks that are good values and have found the following five candidates for addition to your portfolio:

However, you can afford to buy only one of these stocks. Based solely on the stocks expected returns and risk, as measured by Beta, which one represents the best investment? Please justify answer.

Solution Preview

1. Joe's Clambake Company is considering the purchase of a C130 airplane to help spot monster clams on the bottom of Chesapeake Bay. In estimating the worth of adding the plane to the company the following cash flow analysis has been developed:

Cash inflow at the end of year 1: $12,000
Cash inflow at the end of year 2: $12,000
Cash inflow at the end of year 3: $12,000
Cash inflow at the end of year 4: $12,000
Cash inflow at the end of year 5: $12,000
Cash inflow at the end of year 6: $30,000

If Joe's required rate of return is 10%, how much is the plane worth to him today?

We need to find the present value of the cash inflow the six years to find how much the plane is worth to him today.

PV = FV where PV is the present value
(1 + i)n FV is the cash inflow in the future
i is the required rate of return
n is the period

PV = $12,000 + $12,000 + ...

Solution Summary

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